Chapter 10 Capital Investment Decisions. Dongguk University, Prof. Sun-Joong Yoon

Transcription

1 Chapter 10 Capital Investment Decisions Dongguk University, Prof. Sun-Joong Yoon

2 Relevant Cash Flow NPV is the best method! How can we estimate the cash flows from the project? Incorrect cash flows results in a wrong decision even if we use the NPV method. The cash flows that should be included in a capital budgeting analysis are those that will occur if the project is accepted These cash flows are called incremental cash flows ( 증분현금흐름 ) 2

3 Pro Forma Statements and Cash Flow Capital budgeting relies heavily on pro forma accounting statements, particularly income statements Computing cash flows refresher Operating Cash Flow (OCF) = EBIT + depreciation taxes OCF = Net income + depreciation (when there is no interest expense) Cash Flow From Assets (CFFA) = OCF net capital spending (NCS) changes in NWC year Last year Cashflows - NCS - NWC + NWC +OCF +OCF +OCF +OCF Note that working capital investment is recalled at the end of the project. 10-3

4 Depreciation The depreciation expense used for capital budgeting should be the depreciation schedule required by the IRS for tax purposes Depreciation itself is a non-cash expense; consequently, it is only relevant because it affects taxes Depreciation tax shield = DT D = depreciation expense T = marginal tax rate 10-4

5 Computing Depreciation Straight-line depreciation D = (Initial cost salvage) / number of years Very few assets are depreciated straight-line for tax purposes MACRS ( 수정가속상각법 ) Need to know which asset class is appropriate for tax purposes Multiply percentage given in table by the initial cost Depreciate to zero Mid-year convention After Tax Salvage If the salvage value is different from the book value of the asset, then there is a tax effect Book value = initial cost accumulated depreciation After-tax salvage = salvage T(salvage book value) 10-5

6 Example: Depreciation and After-tax Salvage You purchase equipment for $100,000, and it costs $10,000 to have it delivered and installed. Based on past information, you believe that you can sell the equipment for $17,000 when you are done with it in 6 years. The company s marginal tax rate is 40%. What is the depreciation expense each year and the aftertax salvage in year 6 for each of the following situations? 10-6

7 Example: Straight-line & Three-year MACRS (Straight-line) Suppose the appropriate depreciation schedule is straight-line D = (110,000 17,000) / 6 = 15,500 every year for 6 years BV in year 6 = 110,000 6(15,500) = 17,000 After-tax salvage = 17, (17,000 17,000) = 17,000 Three-year MACRS Year MACRS percent D (110,000) = 36, (110,000) = 48, (110,000) = 16, (110,000) = 8,151 BV in year 6 = 110,000 36,663 48,895 16,291 8,151 = 0 After-tax salvage = 17, (17,000 0) = $10,

8 Example: Replacement Problem Original Machine Initial cost = 100,000 Annual depreciation = 9,000 Purchased 5 years ago Book Value = 55,000 Salvage today = 65,000 Salvage in 5 years = 10,000 New Machine Initial cost = 150,000 5-year life Salvage in 5 years = 0 Cost savings = 50,000 per year 3-year MACRS depreciation Required return = 10% Tax rate = 40% 8

9 Replacement Problem Computing Cash Flows Remember that we are interested in incremental cash flows If we buy the new machine, then we will sell the old machine What are the cash flow consequences of selling the old machine today instead of in 5 years? 10-9

10 Replacement Problem Pro Forma Income Statements Year Cost Savings 50,000 50,000 50,000 50,000 50,000 Depr. New 49,995 66,675 22,215 11,115 0 Old 9,000 9,000 9,000 9,000 9,000 Increm. 40,995 57,675 13,215 2,115 (9,000) EBIT 9,005 (7,675) 36,785 47,885 59,000 Taxes 3,602 (3,070) 14,714 19,154 23,600 NI 5,403 (4,605) 22,071 28,731 35,400 Hallym University, Prof. Sun-Joong Yoon, Fall 2010

11 Replacement Problem Incremental Net Capital Spending Year 0 Cost of new machine = 150,000 (outflow) After-tax salvage on old machine = 65, (65,000 55,000) = 61,000 (inflow) Incremental net capital spending = 150,000 61,000 = 89,000 (outflow) Year 5 After-tax salvage on old machine = 10, (10,000 10,000) = 10,000 (outflow because we no longer receive this) 10-11

12 Replacement Problem Cash Flow From Assets Year OCF 46,398 53,070 35,286 30,846 26,400 NCS -89,000-10,000 In 0 0 NWC CFFA -89,000 46,398 53,070 35,286 30,846 16,400 Hallym University, Prof. Sun-Joong Yoon, Fall 2010

13 Replacement Problem Analyzing the Cash Flows Now that we have the cash flows, we can compute the NPV and IRR Enter the cash flows Compute NPV = 54, Compute IRR = 36.28% Should the company replace the equipment? 10-13

14 Q & A Dongguk University, Prof. Sun-Joong Yoon